'Equities to trade sideways with negative bias till Sept'

As we entered this week, hopes were high that central banks, both at home and globally, would aid the global economy by announcing stimulus measures. But three policy meetings later, markets are still left waiting.

The Reserve Bank of India and the US Federal Reserve did not announce any stimulus measures in its policy statements, but this was expected by the street. However, markets took a hard blow as the European Central Bank also failed to move on further stimulus. ECB chief Mario Draghi yesterday announced no interest cuts or any other stimulus measures, but did say they were open to more open market operations to buy bonds. The negative reaction to his statements was seen immediately after, as both US and European markets ended the day with sharp cuts. So has inaction from the ECB triggered a shift in sentiment, from risk-on to risk-off? Possibly so, according to Robert Parker of Credit Suisse AMC, but only for the short term. In an interview to CNBC-TV18, Parker says that equity markets will trade sideways with a downward bias for the next couple of week, or atleast till September. “As we go into late-August, early September, there is a high probability that global equity markets actually build on the rally that started in late June,” he said. Also read: Religare Cap sees chances of Nifty testing 4800 Below is an edited transcript of his interview with Udayan Mukherjee. Q: Where does what Mario Draghi had to say leave Spanish and Italian yields? A: What they have said is that they are working on a plan to intervene with the purchase of short duration and not long duration bonds. That's very important, because the pressure on Spain and Italy in recent weeks has been on the short end of the curve rather than the longer end of the curve. But, we do not know when this is going to happen and we do not know whether the ECB has got full German support for that action. Also, we do not know the extent to which they would intervene. So when he made a statement recently in London, saying they would do everything that it takes to defend the euro, to support the eurozone, that wasn't. Q: What about the European Stability Mechanism (ESM) banking license, because Draghi lopped the ball directly onto the German’s court or the court of the governments? Do you see the governments playing along? A: What Mario Draghi said was legally 100% correct. It is not permissible for the ECB to have any influence on whether the ESM gets any banking licence or not. Obviously if the ESM did get a banking licence, that would make its role in markets much more powerful because it would be able to leverage its capital resources. Without a banking licence, its ability to leverage its position and leverage its influence in the market is somewhat limited. We have got a mixed response from the European governments. Some have indicated that they would accept a banking licence for the ESM. The message from the German government seems to be shifting ground a bit, but even so, there is I think still German resistance to a banking licence being granted. _PAGEBREAK_ Q: Do you see this resistance to buying bonds also continuing from the Germans, even if Spanish and Italian yields go up sharply as they started to yesterday? A: Eventually, probably yes. But as of today, there still seems to be German Bundesbank resistance to the ECB acting aggressively in the purchase of Spanish and Italian bonds. On the ECB governing council meeting, Mario Draghi reported that there was a unanimous vote in support of the intervention with one exception. He obviously did not say who that one exception was, but one can assume that it was the representative from the German Bundesbank. So the message that at least the markets have received today is that there is still Bundesbank resistance to the ECB purchase of sovereign bonds. Q: The market reaction to yesterday’s statement has not been great, but do you expect this current phase of risk-on to meet with serious challenges going forward? A: My view is that this concept of 'risk-on' and ‘risk-off' is actually in the process of changing. Clearly, equity markets have rallied since the third week of June, but this week we have had a negative market reaction. Today, I actually think investor flows would be driven by number of other factors rather than these short-term risk-off and risk-on trades. Having said that, over the next few weeks, probably going into late-August, I am assuming that the markets will probably trade sideways with a downward bias. But as we go into late-August, early September, there is a high probability that global equity markets actually build on the rally that started in late June. Q: What are your expectations from the US Fed? At the Jackson Hole meeting or the September 13 meeting, are you expecting any firm commitment or of QE3? A: I think there is a very high probability that the Fed will initiate QE3 that could be USD 600 billion, both in the US treasury market and the mortgage backed securities market. That would take its balance sheet to USD 3.5 trillion. They may also take action on interest rates that they pay when banks deposit money with the Federal Reserve. That would be the logical thing to do because it would discourage banks from leaving idle funds with the Fed and encourage banks to lend into the real economy. Obviously Ben Bernanke at the end-August Jackson Hole meeting will give an important policy statement. In that policy statement, I think he is going to continue to air his concerns that the recovery in US economy is troublesome. Q: Where does all this leave the euro? We have seen it yo-yo in a band of 1.20-1.24 to the dollar.Where do you see it headed from here now? A: Let us first give some historical perspective. The euro started life at an exchange rate against the US dollar of 1.17. Since the euro has been in existence, its range against the US dollar has been a low of 0.82 and a high of 1.6. Today, we are in a range between 1.2 to probably 1.23-1.25. Recently there has been a historically high short market position on the euro and that actually gives support for the euro around current levels. In comparing the euro against the dollar, we have the age old problem of comparing one weak currency against another weak currency. Interest rate differentials are marginally supportive for the euro. If we go into QE3 from the Fed, that should support the euro. My view, for at least the next three months, is that we are in a trading range around current levels on the euro, probably a low of 1.17-1.18 and a high of 1.25-1.26. At these levels of the euro, Northern Europe led by Germany is super competitive. Going back to Mario Draghi’s comments, he makes the observation that Southern Europe still has a competitiveness problem. He didn’t, however, make the statement that with the euro close to 1.20, German industry and most of the northern European industry is super competitive. So we have a situation where the exchange rate is great for one part of the euro zone but it is still troublesome for the southern part of the euro zone.